Whenever you make an investment into stocks or bonds it is critical to keep track of your basis in the investment.

The basis may sometimes be referred to as cost basis, adjusted basis, or tax basis but regardless of the name that is used it is very important to accurately track this information.

Without tracking the basis you have no idea of what you truly invested in the item and you could ultimately pay taxes on the entire sales proceeds without adequate cost basis records.

When a security is sold the investment institution is required to issue a form 1099-B for the gross proceeds associated with the sale. The taxpayer and the IRS both receive a copy of this form 1099-B.

Thus, the IRS knows the proceeds from the sale.

If the taxpayer does not accurately report this sale on their income tax return the IRS automatically assumes there was zero basis associated with this sale, assumes that the sale was a short-term sale, and computes the taxes based on these factors which results in the highest possible tax associated with this sale.

I cannot tell you how many taxpayers I have met that did not accurately track their cost basis and were not concerned about this until they received a notice from the IRS for incorrectly reporting a sale of an investment.

Your basis is basically what you have invested in the asset. This figure is then used to compute the corresponding gain or loss when the asset is sold.

So, how is the cost basis determined?

For securities you have purchased the cost basis is what you paid for the investment plus any commissions you paid to acquire the investment. However, if you had a dividend reinvestment plan in place in which any dividends that the stock paid were used to purchase additional shares this also must be added in to the cost basis as you paid taxes each year on these dividends and these dividends added to your cost basis.

If, on the other hand you received the investment as a gift the calculation of the cost basis varies a bit, and is ultimately dependent on whether your sale results in a profit or a loss.

If you sell the security for a profit your basis is the same as that of the previous owner. The basis of the previous owner is transferred to you along with the property transfer.

However, on the other hand, if you sell for a loss the basis is either the previous owner’s basis in the stock or the value of the stock at the time of the gift, whichever is lower.

This law prevents the taxpayer from getting to write off a loss that occurred when the previous owner owned the security.

When you inherit stock or other assets your basis is generally the value of the asset on the date of death of the previous owner.

So, if the investment has appreciated since the original owner purchased it your basis is “stepped up” to the market value at the date of death. As a result, any income tax on any profit that was generated while the previous owner was alive is effectively forgiven.

You become responsible only for the tax that resulted from any appreciation after you inherit the stock, and if the stock price falls from the inherited value you can claim a tax loss.

So as you are reviewing your investment portfolio for year-end planning it is important to remember to maintain good cost basis information.

Your investment manager should be maintaining these, but you may have changed accounts, inherited or been gifted the investment and other factors whereby good cost basis information does not exist.

A law that became effective for investments purchased in 2011 and later years requires brokers to track basis. However, to avoid paying more than you need you should spend a little time tracking this information and it will help you come tax time.

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Paul Pahoresky is a partner in the accounting firm of JLP CPAs. He can be reached at 440-974-1040x14 or at paul@jlpcpas.com. Consult your tax advisor for your specific situation for additional information and guidance on these topics.